Price Controls Stimulate Economic Meltdown

August 20, 2007.

PRICE CONTROLS STIMULATE ECONOMIC MELTDOWN

It is quite an irony that when it came to celebrating Heroes Day on 13 August 2007, there was a shift in focus from remembering the fallen heroes to worrying about economic and political problems besetting the country. The state media was awash with propaganda meant to shore up ZANU (PF)'s image as a liberation war party. In contrast, in their homes Zimbabweans have been struggling with severe shortages of fuel, food and foreign currency for the past seven years. And now the few pleasures of life are rapidly disappearing: the revolution is devouring its children.

The policy of price controls has been a problem in Zimbabwe's troubled economy since the first decade of independence. At the height of price controls in the mid-1980s and introduced again in October 2001, there were shortages of essential commodities such as bread, cooking oil and rice. It is obvious that the decision to re-introduce price controls on 25 June 2007 was a political move by the government to please the electorate as Zimbabwe neared the harmonised presidential, parliamentary and council elections in March 2008. The excuse that it had introduced controls because consumers could no longer afford these basic commodities was not watertight.

Admittedly, it was quite frustrating for consumers to watch as prices were increasing on a daily basis. Retailers and manufacturers, grappling to cope with an inflation rate now believed to be well over 10,000%, had been raising their prices several times a day. However, the government has failed to address the root causes of the problem which are the continued disruption of agricultural production, the lack of commitment to respect private property rights, government profligacy, political violence, rampant graft and price distortions in the economy.

The appeal of price controls is easy to divine. Even though they fail to protect many consumers and hurt others, controls hold out the promise of protecting groups of consumers who are particularly hard-pressed to meet price increases. The maximum price for maize-meal or bread is supposed to protect the poor, who depended on maize-meal and bread to survive; and rent controls are supposed to protect those who rent at a time when demand for apartments appear to exceed the supply and landlords are able to "gouge" tenants.

However, despite the frequent use of price controls, and despite the superficial logic of their appeal, economists are generally opposed to them, except perhaps for very brief periods during emergencies. The reason is that controls on prices distort the allocation of resources. To paraphrase a remark by Milton Friedman, economists may not know much, but they do know how to produce a surplus or shortage. Price ceilings, which prevent prices from exceeding a certain maximum, cause shortages. On the other hand, price floors, which prohibit prices below a certain minimum, cause surpluses.

Suppose that the supply and demand for cooking oil are balanced at the current price, and that the government then fixes a lower ceiling price. The amount of cooking oil supplied will be reduced, but the amount demanded will increase. The result will be excess demand and empty shelves. Although some consumers will be lucky enough to purchase cooking oil at the lower price, others will be forced to do without.

The price crackdown, dubbed Operation Dzikisa Mitengo (Reduce Prices), has resulted in empty shelves because retailers cannot afford to restock at a loss. The major victims of this disaster are the povo whom the ZANU (PF) government claimed to be protecting when it launched the price clampdown on businesses. Basic commodities like maize-meal, sugar, cooking oil, bread and meat have found their way onto the black market where they are being sold at exorbitant prices which are beyond the reach of ordinary Zimbabweans.

For example, beef is being sold at a price of Z$100,000 a kilogram. This is despite the government imposed price of Z$90,000 per kg. The Cold Storage Commission (CSC), the quasi-government firm that handles the production and marketing of beef, is struggling to meet demand, even though the parastatal increased the price of a head of cattle from Z$3 million (US$12) to Z$12 million (US$48). This is still far short of the Z$40 million (US$160) price that was obtainable before the price blitz.

Restaurant and fast-foods outlets have been forced to withdraw their menus as meat, chicken and other basics have run out. Even chicken and pizza takeaways are running out of food and closing early. Under normal circumstances, food outlets are open twenty-four hours a day. Here is a country that cannot feed itself when it used to be the bread basket of the region!

It is now a predictable cliché, in the face of populist and often ill-conceived policies, Mugabe's insistence that the sharp price increases were part of a conspiracy between business and Western powers to foment rebellion against his government and oust it from power. The business sector immediately became the new enemy, denounced as "agents of regime change", forcing up prices deliberately to stoke up discontent that would spill over into mass street violence.

To counter this so-called conspiracy, the authorities have arrested executives in commerce and industry for flouting price controls. At least 7,600 shop managers and business executives have been arrested in a crackdown on businesses accused of profiteering. Of these, 601 have so far been convicted by magistrate's courts while the majority of them were released after paying admission of guilt fines as some cases are pending before the courts.

When the government re-imposed price controls, it had hoped to reduce inflation. However, Zimbabwe's run-away inflation continues unabated. This has dashed government hopes that price control would reduce the suffering of Zimbabweans. News that inflation is now into five-digit psychological barrier has caused dismay among both consumers, whose purchasing power is being seriously eroded, and business, whose costs of production are rising fast. It is reported that the government has suppressed the publication of statistics on inflation by the Central Statistical Office (CSO) since the 4,500% figure of May 2007. Nonetheless, the year-on-year inflation rate continues to rise despite the imposition of price controls by the government.

In a comment, the IMF said, ‘Price controls that are being enforced are likely to exacerbate shortages and, ultimately, fuel inflation. If the current trend continues, year-on-year inflation could well exceed 100,000 per cent by year end.'

It is acknowledged that the directive to slash prices to those obtaining on June 18 triggered panic buying and excessive hoarding characterised by criminal elements taking advantage of this programme, resulting in retail shops being cleared of goods. Due to the uncertainty associated with the sustainability of reduced prices and the availability of commodities, consumers rushed to hoard basic commodities for both consumption and speculative purposes. Because of the chaotic implementation of the policy, the operation has been characterised by massive hoarding which has led to shortages in the formal market.

The police, who are among the lowest paid civil servants in Zimbabwe, have taken advantage of the chaos brought about by the price crackdown to loot basic goods that they sell on the illegal parallel market at exorbitant prices. Senior government officials and senior police officers who are members of the price control inspectorate took advantage of their positions to loot shops. What it means is that those responsible for enforcing the price cuts are openly running a black market in the goods. Meanwhile, ordinary people cannot get goods and prices are going up faster than before.

Even the cash-strapped Zimbabwe government is reported to be diverting food seized from businesses and individuals, accused of overcharging, to feed starving soldiers, patients and prisoners amid reports that hunger is stoking most state institutions. Police sources at the beginning of this month said they had been ordered to stop public auctions of the confiscated goods to allow government institutions such as the army, prison service and hospitals to get the food. The Ministry of Health and the Zimbabwe National Army were the largest recipients of the confiscated goods, it was reported.

It was also reported that price monitoring crack teams had been told to intensify seizures of goods as opposed to asking vendors or shops to sell to the public at gazetted prices. These crack teams have, since early July, raided shops accused of defying the price control order, seizing goods or ordering prompt sales at state approved prices. Cross border traders who buy commodities like sugar, cooking oil, eggs and rice from neighbouring Botswana and South Africa have also had wares seized at roadblocks or from the streets.

Army barracks, prisons and state hospitals have fought food shortages over the past few years as the government failed to find money to buy enough stocks for soldiers, prisoners and patients. Sources said Defence, Health and Home Affairs ministers have in recent weeks told President Robert Mugabe during weekly cabinet meetings that hunger was causing deaths at hospitals and prisons while affecting morale in the army.

The damage goes beyond that. Most boarding schools are not likely to reopen next month because of food shortages. Hospitals are already grappling with the shortages and some might close down. Most pharmacies have run out of medicines.

In its latest assessment report, the United States-based Famine Early Warning System (FewsNet) said the Zimbabwean government's controversial price controls was further worsening household food security in a country where the majority of the people can barely make ends meet. It warned that the poor have been left more vulnerable to food insecurity following the disappearance of basic commodities from Zimbabwean shop shelves.

"The run on commodities is having the biggest impact on the poor, who are forced to make frequent purchases in smaller amounts and are not able to buy in bulk when commodities become available," observed FewsNet.

The cost of a household's monthly basket of goods monitored by the state-controlled Consumer Council of Zimbabwe was pegged at Z$12.6 million for June before price controls lowered the cost to Z$8.3 million. Such a family needed Z$3.3 million to survive in April 2007 and Z$5.5 million in May, representing month-on-month inflation in May of 65.6%.

FewsNet said besides the impact of price controls, Zimbabwe's overall food security situation was poor this year compared to other years, largely due to the protracted economic decline and the poor 2006/07 harvest. According to the United Nations' Food and Agriculture Organisation and World Food Programme estimates, Zimbabwe's cereal production for this year is expected to meet only 55% of the country's requirements. The WFP plans to feed more than ten times the 300,000 Zimbabweans it already assists and needs 352,000 metric tons of cereals and other commodities to cover its increased relief activities until the next main harvest in April 2008.

On August 1 2007, the WFP appealed for US$118 million (€86 million) to extend assistance to about 4.1 million Zimbabweans facing severe food shortages over the next eight months.

"Hundreds of thousands of Zimbabweans are already starting to run out of food and several million more will be reliant on humanitarian assistance by the end of the year," said Amir Abdulla, the organization's regional director for southern Africa, in a statement. The situation has been exacerbated by soaring poverty, hyperinflation and the devastating impact of HIV/AIDS.

"Without assistance, vulnerable families will be forced to adopt risky survival measures, including eating potentially poisonous wild foods, selling their remaining household assets, exchanging sex for food and crossing illegally into South Africa," the statement said.

Nearly half of Zimbabwean industrial firms are on the verge of collapse because of the impact of government-imposed price controls, which have forced many companies, already battling escalating production costs, to trade at a loss. Most manufacturing firms are struggling to import raw materials, machinery and spare parts because of an acute foreign currency crisis partly caused by a severe decline in Zimbabwe's export sector. Manufacturers have said the government-imposed prices mean they are unable to cover their costs and stores are fast running out of supplies, while the black market is booming.

Most companies are likely to declare losses and will therefore technically not be liable to pay corporate tax to the government. With company closures comes unemployment which will reduce government's income tax revenue. These price controls will inevitably drive the economy deeper into recession.

About 400 companies closed down in 2001 and 249 in 2002 due to the harsh operating environment. At least 1.2 million jobs have been lost in the formal sector since 2000 because of the company closures, pushing unemployment to 85% according to Zimbabwe Congress of Trade Unions (ZCTU). Between December 2002 and April 2003, about 350 firms closed shop, leaving more than 350,000 workers without employment. Estimates show that between 240,000 and 400,000 jobs were lost in three years from January 2004 to December 2006.

The price war has accelerated the exodus of Zimbabweans into the SADC region. There is a tremendous increase in the "brain drain", as more and more Zimbabweans strive to survive by seeking livelihoods in other countries. Reports say that about 4,000 Zimbabweans are illegally crossing every night and about 6,000 are deported every week from the border town of Messina. Even the UN High Commissioner for Refugees (UNHCR) has made a contingency plan in anticipation of thousands of Zimbabwean refugees fleeing their country's worsening political and economic situation.

In the first six months of 2007, the UN International Organisation for Migration processed 117,743 people repatriated from South Africa at its facility at Beitbridge on the Zimbabwe border, about 40,000 more than in the last six months of 2006.

Meanwhile, the Zimbabwe government's ability to finance its activities will be severely constrained by the shrinking tax base. Government revenue is likely to be reduced in areas of value added tax (VAT) on reduced company sales; VAT refunds by the Zimbabwe Revenue Authority (Zimra); corporate tax through reduced production and company closures and individual income tax through increased unemployment. Sources at Zimra said the clampdown on businesses is likely to reduce government revenue from VAT and Income Tax by about 40%, a situation that would force the state to continue its reliance on money printing and domestic borrowing to fund its activities. (It is pertinent to state that this type of financing increases inflationary pressures.) Zimra has since revised its revenue target for this year from Z$30.2 trillion to Z$1.1 trillion. Information to hand shows that Zimbabwe's taxable income is set to decline by over 45% from Z$85.5 trillion to Z$47 trillion. This means business concerns countrywide will lose a staggering Z$38.5 trillion as a direct cause of price freezes.

A recent study shows that the total revised estimated government revenue for 2007 is Z$30.2 trillion, with a respective nominal GDP of Z$85.5 trillion. (Nominal GDP is the total output in an economy.) This will force Zimbabwe's economy to sink deeper than it has already. "The recent price control initiative is likely to result in revised total revenue of Z$17.1 trillion, implying a loss in revenue of Z$13.1 trillion," says the study.

With the domestic debt currently at Z$8 trillion as of July 6, the government is struggling to cope with huge interest payments of Z$6.08 trillion. Economic analysts say that the inflationary effects highlighted in the study could not be overstressed.

The crackdown has also hit revenue from exports as companies are forced to push their products into the local market to cover the shortages. It is estimated that revenue from exports will be reduced by US$132 million because of the operation. This means that there will be less foreign currency to import food, fuel and electricity.

Exports have gone down by 60% in the past four years on the back of systematic destruction of the tobacco industry and horticultural exports. Tobacco production, which contributed 40% of export earnings before the fast-track land reform programme that started in 2000, has crashed by 70% and exports have also slumped significantly. Economic figures show that the nation's exports declined by 14.2% to US$1.2 billion in 2006, from US$1.4 billion in 2005.

The president has, through the Reserve Bank of Zimbabwe (RBZ), often ordered the printing of money to finance unbudgeted spending to appease his supporters. Quasi-fiscal activities by the RBZ have been blamed for Zimbabwe's high inflation rate and budget deficit. The recent subsidies to gold and tobacco producers and the anticipated subsidies to companies affected by the ongoing government purge on prices are seen exerting additional pressure on Zimbabwe's already huge budget deficit.

Whenever the governing authorities pass laws requiring an owner or supplier to sell an item for less than the market price, the result will be a shortage. It's just a law of economics. And contrary to what government officials throughout history have believed, no government can repeal a law of economics any more than it can repeal the law of gravity. The artificially low price has a twofold effect: it causes supplies to be withheld from the market and it induces people to consume more than they ordinarily would. There is only one solution to the shortages and long queues: eliminate the price controls. Instead the Harare authorities are dealing with the symptoms before addressing the cause of the crisis. There is an urgent need to address the politico-economic fundamentals which are pushing the economy into this quagmire.

Price controls do not, in practice, stabilise prices and minimise inflation. What they achieve is the creation of shortages, as manufacturers discontinue or reduce production progressively as rising costs destroy operational viability. Advocates of price controls need to know that the only way prices can be stabilised or reduced are by the elimination of shortages, and the stimulation of competition. The law of supply and demand states that the price of an economic good is determined by the interaction of supply and demand. If supply is greater than demand at any one time, the surplus will generate a downward pressure upon price. And conversely, if demand is greater than supply, the scarcity will force prices up. It follows that there must be a price at which the amount offered equals the amount required.

State-imposed price controls and food shortages caused by drought and the government's controversial land reforms had spawned a thriving black market in basic foodstuffs, lifting the prices of these by more than ten times in the past seven years alone.

Thus, to bring the rampant inflation under control, the government must curb its own expenditure, by containing corruption, by achieving exchange rate stability and by encouraging the growth of productivity of labour and enhanced production efficiencies.

Operation Dzikisa Mitengo (Reduce Prices) has undermined business confidence and acts as a deterrent to both domestic and foreign investors. Investors shun away from environments that are fraught with controls which impact on their return on investment. As a result, the much celebrated "Look-East" policy has failed to attract serious and meaningful investments to shore up Zimbabwe's struggling economy that is in its eighth straight year of recession. This fact was underlined by President Mugabe himself. In a speech commemorating Defence Forces Day in Harare on 14 August, Mugabe appealed to "true and genuine friends" to invest in the "abundant natural resources" of Zimbabwe. It is also with irony that Mugabe's calls for investors to come to the country comes as his government is currently working on legislation to nationalise some key sectors of the economy under the pretext of black economic empowerment. The new legislation will empower the ZANU (PF) government to seize a fifty-one-percent stake in all foreign-owned companies including in the key mining sector.

The loss of confidence and uncertainties about the future viability of companies has direct limitation on most firms to access offshore lines of credit. The country's perceived risk is now much higher, making it difficult for even the government to access bilateral finance from friendly countries such as China. Economic analysts have warned that the new legislation will scare away potential investors and plunge Zimbabwe's struggling economy deeper into the mire.

The price blitz shows that the crackdown has had disastrous consequences, undermining government's stakeholder-driven turnaround initiative - the social contact, reducing government revenue, fuelling the parallel market, eroding investor confidence and militating against efforts to reduce inflation. Empty supermarket shelves and long queues across the country have provided the clearest signs that the price slash has dismally failed, only compounding the current economic crisis that has shattered the once robust economy.

It can be recalled that in post-World War II Germany, the Allied occupation officials imposed an extensive set of price controls on the German economy. When Ludwig Erhard, the free-market leader of Germany, asked the officials to lift the controls in order to relieve the economic plight of the German people, they refused, claiming that an immediate lifting of controls would produce chaos. One Sunday morning, to the surprise of everyone, Erhard issued a public announcement lifting the controls. It was that action, more than anything else, that led to what became known as the German "economic miracle."

It is unfortunate that the ZANU (PF) Politburo today has failed to learn both economics and history. Government policies have betrayed rational logic and have caught the Harare authorities in irretrievable difficulties from which escape is almost impossible - if only they could identify the source of the problem. To blame Britain and the USA for Zimbabwe's economic meltdown, smacks of a ZANU (PF) leadership caught in self-deception.